FCA confirms new rules for payment optionality for investment research

The FCA has published its final rules on introducing a third option for investment managers to purchase research services through joint research and execution payments. These largely confirm the so-called “guardrails” for this new approach announced in CP24/7, itself a product of the Investment Research Review set up by the Treasury in March 2023. The new rules came into effect from 1 August .

It is important to note that the joint payment option currently only applies to MiFID investment firms, and not for AIFMs and UCITS Mancos. The Policy Statement notes that the FCA will consult on an equivalent option for these categories of firms later in 2024.

The Policy Statement made some relatively minor refinements to the original proposals:

• Budgeting: the consultation provided examples of how budgeting could be done at the level of an investment strategy or group of clients. The final rules clarify that there can be aggregation at a level that is appropriate to a firm’s investment process, products, services, and clients. The FCA has also clarified that budget overruns should be disclosed to clients “as soon as reasonably practicable” – for example, through the next periodic report on costs and charges – rather than a separate communication being required.
• Research provider disclosures: these requirements have been amended in two ways. Disclosing the most significant research providers has been replaced by disclosing the types of providers – for example, independent vs non-independent research providers. Secondly, the level of aggregation at which such disclosures are made should mirror budgeting, as above (i.e. appropriate to a firm’s investment process, products, services, and clients). These changes address concerns about disclosures that are either uninformative or commercially sensitive. It is also clarified that actual amounts paid to research providers do not need to be disclosed.
• Price benchmarking: the specific requirement to undertake benchmarking of prices paid for research against relevant comparators is replaced by an obligation to ensure charges are “reasonable”, clarifying that benchmarking is one way of demonstrating compliance.
• Cost allocation and disclosure: Latitude is provided in the final rules on the fair allocation of costs, provided these are appropriate to a firm’s investment process, products, services and clients. As well as mirroring the modified budgeting and disclosure guardrails described about, there is now more flexibility on estimating expected annual costs to clients.
• Separately identifiable research charges: the requirement to separately identify research and execution charges within written agreements is replaced by the need for “arrangements” to be in place. This better reflects a range of market practices, including bilateral agreements and multilateral through service providers

By way of reminder, the main requirements for adopting the joint research and execution payment approach are:

• A written policy describing the firm’s approach to joint payments including governance, decision-making and controls.
• An arrangement that stipulates the methodology for calculating and separately identifying the cost of research within joint payments.
• An allocation payment structure that determines payments across research providers, including independent providers as well as firms offering both execution and research.
• The firm must be fully responsible for the administration of accounts purchasing research through joint payments, ensuring that this does not interfere with its regulatory obligations as well as timely payment.
• A budget for the purchasing of research which is reviewed at least annually, at a level of aggregation appropriate to its investment process, products, services, and clients; and based on expected need, as opposed to being based on volumes or values of transactions.
• Fair allocation of costs of research purchased between clients.
• Periodic assessment of the value, quality, use and contribution to investment decision-making of the research purchased, and how the firm ensures that charges to clients are reasonable against relevant comparators, to be undertaken at least annually.
• Disclosure to clients on the firm’s approach to joint payments, including for instance if and how they are combined with any other payment option, the most significant research services purchased, and costs incurred.

The final rules confirm that research services cannot be a factor in assessing best execution, and that the best execution rules of COBS 11.2 continue to apply unchanged. The existing rules on other payment options will not be changed. Other changes include adding short-term trading commentary and advice linked to trade execution to the list of acceptable minor non-monetary benefits for all payment options.

The FCA are also deleting the rule relating to investment research on small and medium-sized enterprises with a market capitalisation below £200 million, which was introduced through PS21/20 and has had little take-up. Thus, the new option for joint payments will also apply to such small companies. However, the recently introduced rule on treating corporate access to companies with a market capitalisation below £200 million as an acceptable minor non-monetary benefit is retained.

It is important to note that the joint payment option currently only applies to MiFID investment firms, and not for AIFMs and UCITS Mancos. The Policy Statement notes that the FCA will consult on an equivalent option for these categories of firms later in 2024.